W I T N E S S E T H:

Law Profs Bag $87,500 Seagull

Law professors Jonathan Klick (U Penn Law) and Joshua D. Wright (George Mason Law) have posted a paper, Grocery Bag Bans and Foodborne Illness, that has been making the rounds in the news and blogs in the last few days. The paper argues that the bans on plastic bags in San Francisco and other California cities have caused a spike in the rate of illness and death from foodborne illnesses such as E. Coli and salmonella.

Cities banned plastic bags in response to claims that the bags increase the costs of waste disposal and harm marine animals. But according to the article, the bag bans have exacted a serious human toll; after San Francisco's enactment of the first major plastic bag ban in 2007 the number of emergency room visits and deaths related to foodborne illness increased sharply. According to the article, the reason may be that consumers rarely wash the bags, mixing residues from raw meat, vegetables, and other items together over time creating a Petri dish of bacteria in which food items marinate. Of course, the authors' observational study does not prove that the bag ban caused the increase in illness, but overall the authors' argument seems persuasive.

Since 2007, the bag bans have been spreading in California like an epidemic. After San Francisco, three other California cities quickly enacted the bans: Malibu, Fairfax, and Palo Alto. The bag ban hits close to home for me, as my town is one of the four called out in the article. As a resident of a "Malibu-adjacent" neighborhood, I have had the opportunity to "enjoy" the twin benefits of the increased seagull and salmonella populations. And I am no longer alone, as the bans are now much more widespread than these initial four cities.

The law profs' study has attracted some significant coverage in the last few days, but the major outlets seem to have overlooked the most astounding calculation from the paper, perhaps because one would need to read the paper to find it. The authors estimate that the additional deaths from the plastic bag ban value each saved animal at $87,500. Perhaps more significantly, this figure only takes into account the costs of those people killed by foodborne illness, not the legions hospitalized, sickened, absent from place of employment, or otherwise incapacitated because of eating food out of filthy cloth bags. One can only imagine that the number of those sickened is orders of magnitude larger than those killed.

It is possible that residents of these (largely uber wealthy) cities would value each sea lion, harbor seal, dolphin, and other endearing animal at $87,500. (I wonder how they value the fish populations that are decimated by the overpopulation of sea lions off the Pacific coast.) My guess, however, is that the primary beneficiary is the elusive Pacific Sea Rat (a.k.a. the seagull), which is one of the few things more unappealing to have in direct contact with food than reusable fabric shopping bags. One would guess that even in Malibu, Marin, Palo Alto, and San Francisco, one could come to a consensus that $87,500 is too steep a price for a seagull.

The plastic bag ban is but one of thousands of examples of regulatory zeal gone awry in California. As I have argued before, California's inability to consider the costs of regulation is turning the state's economy into a rustbelt economy. I hope more law professors will follow the lead of Klick and Wright, conducting the assessment of the costs and ancillary effects of regulation that our California state and local governments seem unable to perform or uninterested in considering.

Slide in California Angel Investing

The New York Times recently carried an article “Tech Start-Ups Find a Home on the Prairie.” In this article, the Times commented on the Halo Report sponsored by Silicon Valley Bank, the Angel Resource Institute and CNB Insights, in which data from angel investments suggested that in the last year the share of startup companies has moved to the Great Plains region, ostensibly to the detriment of Silicon Valley.

Indeed, the underlying research reports showed that California’s share of angel investing deals declined from 2011 to 2012, a finding consistent with my own research that California’s share of startups has not only decreased between 2011 and 2012, but has been in a decade-long decline. The Halo Report shows a decrease of California’s share of deals from 21% to 15.9% over the last year, while my data shows a much more modest decrease of 18.9% to 17.4%. When I subset down to deals less than $1 million (closer to typical angel investment sizes) my results are slightly closer to those of the Halo Report, with a change from 19.9% to 17.4%. Overall, the relatively close correspondence is confirmation of my finding that startup activity is beginning to shift away from California towards other states.

Where is that activity going? My data here diverge somewhat from that in the Halo Report, but are generally consistent. The thrust of the New York Times article is that angel investing activity is increasing in the “Silicon Prairie,” defined as the “Great Plains” region in the Angel Resource Institute reports. Using the same states as in those reports, my data show only a small increase in startup activity in the Great Plains region, with its share increasing from 5.07% to 5.11% from 2011 to the first half of 2012. But when I subset down to deals less than $1 million, my results grow closer to those from the Halo Report, with an increase in share in the Great Plains from 4.93% to 5.30%.

The Halo Report taken together with my own research is further evidence that startup businesses are abandoning California. Although some increase is occurring in the “Silicon Prairie,” my own data suggests that startups are increasingly popping up anywhere but California. This is the phenomenon I have described as the developing “California Rustbelt” economy.

 

Where Are California's Start-Up Businesses Going?

In the last couple of posts I presented data that shows a decline in California’s share of startup companies and the states that have gained and lost the most startup companies. The natural next question is: where are the businesses going?

The answer, somewhat surprisingly, appears to be “nowhere.”  Using the same data as in the prior post I looked for changes in state location among existing companies by comparing headquarters addresses for companies that filed multiple Form Ds. Over the period (2002-2012), the number of businesses that had moved their headquarters into California was about the same as those that had moved their headquarters out of California. Furthermore, these rates were roughly constant over the period. Thus, at least among startup companies that have filed multiple Form Ds, there is no massive relocation from California to other states.

If companies aren’t leaving California, why has California’s share of startup businesses declined so precipitously? The answer seems to lie not in interstate relocation of existing companies, but in decreased California creation of new ones. The drop in California’s share of startup businesses is not primarily because businesses are packing up and leaving for other states. Instead, it appears that new businesses simply aren’t coming to California in the first place.

This explanation for California’s decline in startup companies makes intuitive sense and is consistent with other studies that have failed to show massive relocation. It is very difficult for a state to lure existing companies away because a move typically involves relocating employees, offices, facilities, and the like. As a result, existing companies, even existing early-stage companies, are somewhat immobile. But true startup companies that have not yet put down permanent roots are often recruiting new employees nationwide. Thus, it’s relatively easy for a startup company to avoid a state that’s hostile to business, and that is what appears to be happening in California.

As a result, California may not have much to fear from established companies leaving the state. But that doesn’t mean California has nothing to fear. The trend of new business creation shifting to other states is more threatening in the long-term to California’s economy than established companies pulling up stakes and leaving. Historically, the reason there have been so many innovative companies in California is not that Californians have a monopoly on innovative ideas; it is that innovative people with ideas come to California from other places to start businesses. If fewer companies are being created in California, the long-term effects on the California economy will be significant.

The data suggest that the brightest days of California new business innovation may well be in the past if the destructive excesses of California’s bureaucracies cannot be reversed. Established businesses will likely stay. New businesses, however, will likely continue to look elsewhere in light of California’s increasingly dire fiscal, regulatory, and business climate. Of course it is always possible that a rebound in the national economy will produce a reversal in these trends. It is also possible, however, that the California of the next decade may not look like the California of today. Instead, the next generation of Californians may well inherit a 21^st Century version of a rustbelt economy.

 

More on the California Rustbelt

The last post documented the exodus of startup businesses from California. In that post, I explored a previously unexamined source of data on startup company activity—Form Ds filed with the Securities and Exchange Commission—to discover evidence of a drop in California’s share of startup businesses over the 2002-2012 period. In this post, I look at which other states are gaining startups companies and which states are losing them.

The table below ranks the largest states in order of percentage gain or loss in each state’s share of startup companies over the 2002-2012 period. The results initially seem to fit the oft-repeated narrative of companies fleeing California for more “business-friendly” states such as Texas. The table shows that Texas had the largest percentage increase in its share of startup businesses while California had the largest percentage decrease in its share of startup businesses.

 

State	Percent Change in Share of Form D Companies 2002-2012
TEXAS	49.89
NEW YORK	47.37
CONNECTICUT	40.62
ILLINOIS	18.08
WASHINGTON	6.42
PENNSYLVANIA	3.63
MICHIGAN	1.86
ARIZONA	-2.17
FLORIDA	-5.57
COLORADO	-18.9
MARYLAND	-19.3
NEW JERSEY	-20.51
OHIO	-22.71
MINNESOTA	-26.71
MASSACHUSETTS	-26.87
GEORGIA	-28.29
NORTH CAROLINA	-29.89
VIRGINIA	-33.96
CALIFORNIA	-35.44

 

Not all of the states among the largest gainers and losers fit the standard narrative of businesses seeking “business friendly” climates, however.  For example, New York and Connecticut had some of the largest gains among all the states, and yet they appear among the least business friendly on many popular rankings based on surveys and expert analyses. Similarly, Virginia appears to have lost companies at almost the same rate as California, yet Virginia typically scores higher than average on rankings of business climate. Are the rankings of business friendly states seriously defective?

It may be that the rankings themselves are reasonable, but that they fail to tell the whole story of startup business creation. Some rankings are based on surveys of business owners, and the survey respondents are likely dominated by small, locally-rooted businesses that cannot realistically relocate anyway, so their views can’t explain startup growth and movement among the states. Other rankings are based on expert analysis of the legal and regulatory climate, but even those likely do not fully explain the location decisions business owners make. Businesses choose among plausible states, rather than all states. A high-tech startup might have trouble finding the talent it needs in the hypothetical state of East Dakota, for example, no matter how “business friendly” that state might be.

In a sense, this explanation may just state the obvious—that there is more to attracting and retaining businesses than the state’s tax and regulatory climate. But I think there is a deeper explanation for the results, however, one in which California’s unique role in the national (and indeed international) innovation economy is the pivotal piece in the puzzle. The next post proposes a theory that all of these results can be attributed to the developing "rustbelt" economy in California.

The California Rustbelt

California has long been virtually synonymous with innovation, venture capital, and economic growth. In recent years, however, the business press has increasingly reported anecdotal accounts of businesses leaving for Texas or other states in frustration over the regulatory environment, tax burden, and budget prospects in California. Is this merely media sensationalism or there really an exodus of entrepreneurial activity from California? A quick look at some previously unexamined data suggests that California may indeed be slowly rusting from the inside out.

I collected data on startup businesses from Form D filings made with the Securities and Exchange Commission for the last decade (2002-2012). These filings are made by startup companies that raising funds in private markets, especially companies in California’s hallmark high-tech and venture capital sectors. The companies that file Form Ds are the Googles and Facebooks of the future, as those companies’ pre-IPO Form D filings can be found here and here. Thus, these filings provide a unique and previously unexamined source of information into the geographical distribution of startup companies raising funds in private markets—a window into what a state’s economic future might look like.

I complied data from 121,560 Form D filings over the last ten years to produce the plot below, depicting the shares of California, New York, and Texas in the startup financing market.

  

The plot reveals an unmistakable bleed of startup businesses out of California over the last decade.  As recently as 2002 California was the clear leader among all states, with about as many businesses as in the next four states combined (New York, Texas, Massachusetts, and Florida), and more than twice as many as its nearest competitor—New York. But by 2012 New York by itself has nearly caught California, and New York and Texas together have a far higher share than California. The trend began well before the financial crisis and housing bubble burst, so those factors do not drive the results.

These figures obviously pose a potential problem for California’s economic growth prospects over the next decade. California is dependent on the innovation economy to sustain its spending and vibrant Silicon Valley startup culture, but the figures presented here pose the question of whether California might be heading toward a "rustbelt" economy itself. In the next post, I look at which states are gaining and losing startup companies, and what that tells us about rankings of states as “business friendly.”